Puerto Rico files for biggest ever US local government bankruptcy

May 3 (Reuters) - Puerto Rico announced a historic restructuring of its public debt on Wednesday, touching off what may be the biggest bankruptcy ever in the $3.8 trillion U.S. municipal bond market.

While it was not immediately clear just how much of Puerto Rico's $70 billion of debt would be included in the bankruptcy filing, the case is sure to dwarf Detroit's insolvency in 2013.

The move comes a day after several major creditors sued Puerto Rico over defaults its bonds.

Bankruptcy may not immediately change the day-to-day lives of Puerto Rico's people, 45 percent of whom live in poverty, but it may lead to future cuts in pensions and worker benefits, and possibly a reduction in health and education services.

The island's economy has been in recession for nearly 10 years, with an unemployment rate of about 11.0 percent, and the population has fallen by about 10 percent in the past decade.

The bankruptcy process will also give Puerto Rico the legal ability to impose drastic discounts on creditor recoveries, but could also spook investors and prolong the island's lack of access to debt markets.

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People protest Puerto Rico's debt restructuring

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People protest Puerto Rico's debt restructuring

People look out of a fast food restaurant as demonstrators participate in a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

A demonstrator uses a slingshot during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

A man dressed in a superhero outfit walks past a burning barricade during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

Police officers use tear gas during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

Demonstrators break the windows of a building during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

A woman covers her face from tear gas during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

Demonstrators sits in front of police officers during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

A demonstrator stands near police officers during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

Demonstrators stand near police during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. The sign reads: "Open your eyes, reflect, join us." REUTERS/Alvin Baez

Demonstrators block the street during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

A person carries a Puerto Rican national flag during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

A demonstrator reacts as police officers stand guard during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

Demonstrators run from tear gas during a protest against the government's austerity measures as Puerto Rico faces a deadline on Monday to restructure its $70 billion debt load or open itself up to lawsuits from creditors, in San Juan, Puerto Rico May 1, 2017. REUTERS/Alvin Baez

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BANKRUPTCY UNDER PROMESA LAW

The debt restructuring petition was filed by Puerto Rico's financial oversight board in the U.S. District Court in Puerto Rico on Wednesday, and was made under Title III of last year's U.S. Congressional rescue law known as PROMESA.

The Title III provision allows for a court debt restructuring process akin to U.S. bankruptcy protection. Puerto Rico is barred from a traditional municipal bankruptcy protection under Chapter 9 of the U.S. code.

The filing includes only Puerto Rico's central government, which owes some $18 billion in debt backed by the island's constitution.

On paper, it does not include $17 billion of sales tax-backed debt, known as COFINA debt, or debt from other agencies.

But those debts are likely to be pulled into the bankruptcy, or included in separate bankruptcy proceedings in coming days, Elias Sanchez, an adviser to Governor Ricardo Rossello, told Reuters on Wednesday.

Puerto Rico's massive pension debts will also likely get restructured in the bankruptcy.

"Title III was especially compelled by the commonwealth's need to restructure $49 billion of pension liabilities," the oversight board said in Wednesday's filing.

BIGGER BANKRUPTCY THAN DETROIT

The previous largest U.S. public bankruptcy, Detroit's in 2013, covered some $18 billion in debt. The city was able to reach an agreed debt restructuring with stakeholders, in part by soliciting huge contributions from philanthropic foundations so it did not need to sell the city's art collection.

But "unlike Detroit, there isn't billions of unencumbered artwork to fund a restructuring" in Puerto Rico, said David Tawil, whose fund, Maglan Capital, held Puerto Rico general obligation debt but has since sold it.

The legal proceeding does not mean negotiations toward a compromise must stop, Governor Rossello said in a statement on Wednesday.

"It is my hope that the Government's Title III proceedings will accelerate the negotiation process," the governor said in the statement.

Rossello's fiscal plan for the island, approved by the oversight board in March, forecasts Puerto Rico having only $800 million a year to pay debt, less than a quarter of what it owes. The low figure alienated creditors and negotiations toward an out-of-court restructuring foundered.

Andrew Rosenberg, a lawyer for the general obligation bondholders, criticized the Title III filing, saying in a statement a consensual deal could have been reached.

"Just as a deal was within reach [on Tuesday], we understand that the oversight board intervened to block it," Rosenberg said in a statement. "For months, the oversight board has made every effort to sabotage consensual negotiations."

Francisco Cimadevilla, a spokesman for the board, denied the allegation, saying in an interview, "I can understand that might be a narrative on the other side, but it's just not the case."

Conversely, Susheel Kirpalani, a lawyer for COFINA bondholders, called bankruptcy "sound public policy," saying in a statement it "enables Puerto Rico to freeze numerous lawsuits" and "maintain essential services."

Analysts and experts agreed the case is likely to take time.

"It will be an orderly process that should be better for creditors in the aggregate than a chaotic and uncertain period involving proliferating lawsuits," said Moody's Investor Services analyst Ted Hampton.

Some expect creditors to challenge the filing, arguing the board did not meet requirements under PROMESA to conduct good faith negotiations out of court.

"We would agree there is a case to be made here," said Keefe Bruyette & Woods analyst Chas Tyson, who follows Puerto Rico. (Writing by Nick Brown; Additional reporting by Jonathan Stempel; editing by Clive McKeef)